Prick asset bubbles early, Stevens urges

Banking reporter

Central banks should be prepared to take the heat out of asset price booms, rather than relying on lower interest rates to "clean up" the mess after bubbles burst, Reserve Bank governor Glenn Stevens has said.

Over the past two decades, economists have debated the merits of central banks "pricking" asset price bubbles by raising interest rates.

While some argued central banks should "lean" on bubbles in the interest of financial stability, others countered that doing so raises greater risks for an economy.

In closed-door remarks from August that were only publicly released on Tuesday, Mr Stevens said the debate had moved on "some way towards doing a bit more leaning."

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"I would have thought that by this point we have to conclude that simply expecting to clean up after the credit boom is not sufficient any more; the mess might be so large that monetary policy ends up not being able to do the job when the time comes," Mr Stevens said.

In a sign the Reserve remains wary the long-term dangers of very low interest rates, Mr Stevens also said that slashing rates to aid other parts of the economy "might leave its own toxic consequences."

Mr Stevens made the comments in a global context, rather than focusing on Australia, at an August conference the RBA ran with the Bank for International Settlements on "Property Markets and Financial Stability."

The Reserve does not have an official policy of targeting asset prices, but some analysts believe the series of six rate rises in late 2009 and early 2010 were influenced by a surge in property prices.

With the cash rate now at a record low of 3 per cent, some economists say it will also be wary about further cuts because of the risk this could inflate house prices.

On the opposing side of the so-called "lean versus clean" debate was the former US Federal Reserve chairman Alan Greenspan. Since the global financial crisis, he has come under criticism for keeping US interest rates low during a housing boom.

Mr Stevens also stressed that interest rates could not do all the work on asset price bubbles.

He said another key lesson of recent years was that governments around the world probably place too much faith in designing tougher bank regulations, rather than making sure they are enforced.

With banking regulators preparing to introduce the latest wave of tougher banking capital rules known as Basel III, Mr Stevens said there was "probably too much tendency to fall for the easy line that if only we can craft better regulations and bring the bankers under control then all will be well."

"Actually it is the application of the rules and framework that matter," he said.